Dominique Strauss-Kahn, the IMF’s Managing Director ended a 6-day trip in Asia by telling Chinese authorities to continue with their stimulus program.
“The main goal is to help with public demand, weak private demand. And the reason why we have to continue with stimulus is because a self-sustaining private demand is not yet visible,” he said.”
He also called for
1) Asian countries to rebalance their economies by becoming less export oriented and fostering internal demand
2) for the renminbi to strengthen to raise household purchasing power and labor’s share of income
Strauss-Kahn said he anticipated Asian growth of nearly 6% for next year (double the forecast for the global economy) and called for Asian leadership in the global financial crisis.
What does this mean?
Let’s start with Eclectica Fund Manager, Hugh Hendry, cited in “Outside the Box” (JohnMauldin@InvestorsInsight.com). Hendry writes:
“Now, if we repeat the Japanese experience then it is possible that nominal US GDP will rise from $14trn today to perhaps just $16trn in ten years time….. The Chinese are building capacity to meet a world where US nominal GDP is $25trn in ten years time. I fear they could be in for a nasty shock.”
That is, the IMF is banking on the remninbi strengthening so that domestic household expenditure can pick up the slack from weakening US consumer demand because there’s huge overcapacity in China.
Serendipitously, just as Strauss-Kahn and the Chinese premier Hu Jintao agreed that domestic demand has to be stimulated, along comes this Bloomberg report that quotes China International Capital Corp. as predicting that Chinese steel demand will rise 12% rather than the 5% predicted by the World Steel Association.
Now, where will the steel go? To a boom in housing construction and auto manufacture.
I blogged earlier that Jim Chanos, the dark prince of short-selling, has declared China a bubble set to burst, on the strength of these mysterious auto purchases that seem to be entirely production driven. One one hand, the government is using its dollars to manufacture cars, demand be damned. But the government has also committed to stimulate demand by social spending (on education and health) that’s intended eventually to make the Chinese loosen up…. and spend on those big-ticket items, like cars and houses.
But there’s an irony in thinking about China’s demand as affecting the commodity market. The irony, says Hendry, is that China is the commodity market.
“Huge demand and numerous small players are a perfect setup for price increases by the Big Three miners, which often cite high spot prices as the reason for jagging up contract prices. But the spot market is relatively small, and mines can easily manipulate spot prices by reducing supply. On the other hand, numerous Chinese steel mills simultaneously want to buy ore to sustain production so their governments can report higher GDP rates, even if higher GDP is money-losing. China’s steel industry is structured to hurt China’s best interests.
The Chinese government is very much wedded to it’s 8% growth target and will do whatever it takes to come close to that target – including flooding the domestic banks with a wall of cheap money to lend as economic stimulus. However, preventing a downturn with easy money is a dangerous way to reflate the economy.
As profitability for the businesses that serve the real economy remain weak, there has been of shift of investment in the first half of 2009 disproportionately into property, stock and commodity markets rather than private sector capital formation. This shift in the medium term threatens to undermine China’s financial stability. Thus, China is experiencing a relatively weak real economy and red hot asset markets.
The Chinese imports that revived the bulk carrier market this year were mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used financing for speculation……
Even more foreboding is a looming real estate bubble. The real estate sector in China is especially critical to the bulk carrier market because approximately 50% of Chinese demand for steel is generated by the construction industry. Most Western shipping forecasts are based on unlimited future need in China for new construction. The reality is quite different. China’s urban living space is 28 square meters per person, quite high by international standard. China’s urbanization is about 50%. It could rise to 70-75%. Afterwards the rural population would decline on its own due to its high average age.
So China’s urban population may rise by another 300 million people. If we assume they all can afford property (a laughable notion at today’s price), Chinese cities may need an additional 8.4 billion square meters. China’s work-in-progress is over 2 billion square meters. There is enough land out there for another 2. The construction industry has production capacity of about 1.5 billion square meters per annum. Absolute oversupply, i.e., there are not enough people for all the buildings, could happen quite soon.
…..The nationwide average price [of housing] is about three months of salary per square meter, probably the highest in the world! Consequently, a lot of properties can’t be rented out at all. Those that can bring in 3% yield, barely compensating for depreciation……
Some argue that China’s property is always like this: appreciation is the return. This is not true. The property market dropped dramatically from 1995-2001 during a strong dollar period. Property prices could drop like Japan has experienced in the past two decades, which would destroy the banking system.